Nornickel - Update on Fuel Spill Accident

Uncertainty about the size of potential fines for the fuel spill in Norilsk and the risk of more capex to tackle the increasing problem of thawing permafrost sent Nornickel stock down 12% in just two days as of yesterday closure. Today, during a video conference with President Putin, Potanin estimated the cost to liquidate the effects of the accident at R10 bln or more. The fines are yet to be estimated, but the overall tone of the discussion was constructive, and the company and state authorities were asked to work in close collaboration to fix the problem. We believe that the company has the situation under control and reiterate our BUY recommendation.> On May 29, accidental damage to a diesel storage tank caused 21 kt of fuel to leak out at Heat and Power Plant 3 (HPP-3), operated by Nornickel subsidiary Norilsk-Taimyr Energy Company (NTEC), in the Kayerkan neighborhood of the city of Norilsk. The fuel leaked into the ground and then spread to the Daldykan River and further on to the Ambarnya River. Overall, around 15 kt of fuel leaked into the water and around 6 kt into the soil. Emergency teams from Nornickel and NTEC immediately arrived at the site to start cleaning up. Special containment booms were installed on the Ambarnaya, which prevented the leak from spreading further. Nornickel has mobilized 250 personnel and 72 pieces of equipment to work on cleaning up the area. As of June 4, 201 tonnes of diesel fuel had been collected near HPP-3, a total of 1,450 m3 of contaminated soil had been removed and approximately 137 tonnes of fuel had been removed from the Ambarnaya River. Today, the Emergency Situations Ministry claimed that the spill was contained on June 1.> Today, Potanin estimated the total cost to liquidate the effects of the spill at R10 bln or more. The fines are yet to be calculated, and the federal agency in charge of overseeing natural resources is expected to finish its review by June 26. There are no precedents for this type of situation in Russia, so it's hard to estimate what the scale of the fines could end up being. Below we provide the history of oil spills and the total related costs, but every case is different and the eventual fines could materially differ from these examples. > Nornickel believes that the accident was caused by thawing of the permafrost under the storage tank. The ground on which the supports for the tank rested started sliding, which caused damage to the tank. However, the investigation is still ongoing. The company has launched a reassessment of all industrial facilities where support posts are driven into permafrost and all facilities that handle hazardous materials. > The company has repeatedly acknowledged permafrost thawing risks in its reporting and constantly monitors soil conditions under its buildings. It measures soil temperatures and has plans in place to ensure that buildings are structurally sound. Nornickel's key plants (Talnakh and Norilsk concentrators, Nadezhda smelter and Copper plant) are built on solid rock, so permafrost thawing is not a problem there. However, for lots of other smaller buildings it is a risk. > It has been reported in the media that a number of apartment buildings in the city of Norilsk have been condemned in recent years due to permafrost thawing. The average temperature this May was plus 4 degrees Celsius - 9 degrees above the average - making this the warmest May on record and likely quickening the pace of thawing. Capex to manage the permafrost thawing is likely already in Nornickel's guidance and any additional increase may be related to reinforcing and strengthening foundations.> Should the total cost of the accident be limited to hundreds of millions of dollars, we believe that the selloff in the stock will prove unjustified. We see Nornickel as a good dividend story and reiterate our BUY recommendation with a target price of $35.70 per ADR.> The company will hold an investor call on June 9 to discuss the accident at 18:00 Moscow (16:00 London, 11:00 New York). The call-in numbers are listed below:> Russia: ; UK: +44 (0) 20 8089 2860; US: ; PIN: 6332708.